In a new paper, Eric Toder, co-director of the Urban-Brookings Tax Policy Center, and Alan Viard, resident scholar at the American Enterprise Institute, discuss the flaws in the United States corporate tax system and propose two options for reform. Toder and Viard examine shortcomings of the current system, including that the current U.S. corporate tax is inefficient, distorts economic decision making, and is poorly designed, allowing many large corporations to avoid paying taxes on profits earned overseas.

To improve the corporate tax system, Toder and Viard suggest two specific reform options. The first option would increase international cooperation on corporate taxation. Greater international cooperation could reduce corporate tax avoidance without placing U.S. corporations at a competitive disadvantage. The second option would achieve the same goal by eliminating the corporate income tax system but expanding the individual income tax system so that it taxes corporate income as it accrues to individual shareholders.

The report’s findings include:

The current corporate income tax is heavily flawed. "Even before considering international implications, the corporate income tax is a problematic tax, because it features multiple distortions that serve little coherent policy purpose. First, corporations are penalized relative to... [other] businesses, which are exempt from corporate income tax. Second, equity-financed corporate investment is penalized relative to debt-financed corporate investment. Third, payout decisions are distorted because dividends are taxed as they are received, but capital gains are not taxed until the gains are realized. As a result, the tax system penalizes corporations that pay dividends... relative to those that reinvest corporate earnings."

Existing reform plans fail to address fundamental flaws. "Many of the reforms being considered in the current debate may yield incremental improvements over the current tax system, but they do not address the fundamental problems [of the system]."

Fundamental reform is needed. "A real solution to the problems caused by today’s corporate income tax won’t be solved by unilateral efforts by the United States government to tweak the system... although some second-order benefits can be gained by plugging specific loopholes and reforming the method by which we tax foreign-source income. A real solution would require either better international coordination of rules to share the corporate tax base among jurisdictions or a shift in tax from the corporate to the individual taxpayer level..."